How it works: the quoted Eurobond dodge explained
In 1984 the Government introduced the “quoted Eurobond exemption”, a little-known regulatory loophole intended to make UK companies more attractive to foreign lenders looking to minimise their tax bills.
When a UK company pays interest to an overseas lender it would usually have to send 20 per cent straight to HMRC. The exemption allowed banks and other investors to receive the interest without the deduction if they lent their money through a “recognised” stock exchange such as the Channel Islands or the Cayman Islands. Almost 30 years on, the tax benefits are being enjoyed not only by third-party investors, but by the owners of UK companies, who are using it to spirit profits through tax havens, while minimising – sometimes eliminating – the company’s UK tax bill.
The loophole is popular with private equity firms, which manage money given by pension funds and others to buy companies and then sell them off at a profit. Instead of investing their money in the shares, or ‘equity’, of the companies they buy, they lend the money, often at eye-wateringly high interest rates through offshore stock exchanges. Their newly acquired companies then take the yearly interest off their profits before they have been taxed in the UK, and reduce their tax bill accordingly.
Often, the interest is not paid to the owners immediately but is accrued and added on to the original loan, increasing the amount taken off the next year. If the owners had invested the money in shares, any dividends they received would be paid after the tax had been calculated. Many companies which use the loophole – and there are lots of them – say this is a legitimate form of investment; and there’s no doubt it is legal.
HMRC could forbid the individual companies from deducting the interest payments from their taxable profits. They’ve done that with some of the interest for a few companies – Pret a Manger and Maplin for example – but not the majority (they refuse to discuss individual cases so we don’t know why some have been stopped and not others).
They could also close the exemption that lets the interest leave the UK tax free. HMRC considered doing that last year but decided not to after lobbying from the finance industry. It’s true that even if they closed it there are other loopholes that the companies could use to spirit the money away but they’re more time-consuming and more likely to be quibbled by HMRC.